5 ms·

This is rather silly explanation of what happend, especially from JP Morgan... Everyone who have ever managed bond portfolio knows that he must hedge interest

by chewz 4y ago

This is rather silly explanation of what happend, especially from JP Morgan... Everyone who have ever managed bond portfolio knows that he must hedge interest rate risk. And every bank is doing that. SVB didn't. Since April 2022 till January 2023 SVB had vacant position of Credit Risk Officer.. And the explanation is simple - SVB's former head of risk, Laura Izurieta had left after 1Q2022 when looses from bond portfolio started to grow. She has probably already realized the final outcome as this is ABC of risk management (and in April 2022 the path of rate increases had been already set in motion by FED). Now look at the timing of insiders selling shares of SVB...

trailrunner46 4y ago
100% agree, taking huge unhedged duration risk and then loading up on negatively convex MBS again unhedged is so crazy.
runeks 4y ago
> Everyone who have ever managed bond portfolio knows that he must hedge interest rate risk. And every bank is doing that. How are other banks hedging interest rate risk? And how is the opposite end of this hedge hedging their position?
- m3kw9 4y ago
  Interest rate swaps maybe. Svb would be on the side that is getting a floating rate payment, while they pay a fixed one to the other side, so when the rates increase it would offset the loss in bond price. Thing is I’m not sure if they need to hedge if the bonds are for 1 year because they will get the money back anyways
- JumpCrisscross 4y ago
  > how is the opposite end of this hedge hedging their position? Plenty of financial functions create natural short interest rate exposure. Like SVB, they have no business speculating on rates, so they hedge it away. (The Fed is also involved in the repo market.)
- oarabbus_ 4y ago
  Any regular bond holding would include a mix of maturities - 1, 2, 5, 10 year bonds. This provides constantly maturing bonds leading to liquid cash with yield on the longest term instruments.
m3kw9 4y ago
what’s the point of needing to hedge if you let the bonds expire and get the payment. You wouldn’t lose anything right?
- runeks 4y ago
  SVB just went bankrupt pursuing that strategy... That being said, I don't think it's possible for all banks to hedge interest rate risk. The risk, to the system as a whole, doesn't go away just because it's transferred to someone else.
  - m3kw9 4y ago
    So their bond prices went down and made them bankrupt, how does the math work in simple terms?
    - runeks 4y ago
      In simple terms, a bond is a piece of paper that pays a dollar amount per year to the holder for N number of years, after which the initial price paid for the bond is returned to the holder. For example, a 10-year bond that pays $2 per year costs $100 today. That is, a piece of paper that pays $2 to the holder every year for 10 years, after which the holder gets its $100 back. Now, some time passes and the market thinks the above bond is too expensive. Instead, the market will only pay $50 for the above bond, ie. $50 to get $2 per year. This means that the price of another bond: the bond that pays $4 per year will now cost $100. This is the case because holding two bonds that cost $50 each and pay $2 per year is exactly equivalent to holding a single bond that pays $4 per year and costs $100. If the market price of a 10-year bond that pays $4 per year costs $100 then we say that the current rate of interest for the 10-year bond is 4%. If this rate of interest falls to 2%, it simply means that the market is now willing to pay $200 per year for a bond that pays $4 per year — or, equivalently, $100 for a bond that pays $2 per year.
      - tome 4y ago
        > after which the initial price paid for the bond is returned to the holder Probably better to say "face value". The initial price paid for the bond may well not be its face value.
wcoenen 4y ago
> Everyone who have ever managed bond portfolio knows that he must hedge interest rate risk. Just a thought: the UK gilt crisis in December was related to pension funds holding long term gilts. And these pension funds all properly hedge the interest rate risk, they normally don't care how rates evolve. However, the market value of the gilts was changing too fast for the hedging to work. My understanding is that money couldn't be moved around fast enough to meet margin calls. Which then caused a bad feedback loop of forced liquidations of gilts, and the Bank of England had to step in to handle the crisis. So with this new story of duration risk at SVB, I'm wondering now whether other banks are in danger. They may have hedged their duration risk, but what if the hedging mechanism turns out to be broken?
- inconceivable 4y ago
  it's even worse than that. the pension funds were selling swaps (paying variable rates). that's why the BoE needed to step in to buy gilts - to drive the yield down and stop the bleeding from both the variable payout and capital losses incurred when liquidating gilts at a loss. zirp has caused some pretty astounding fuckups and i'm sure there are many more to come. https://www.reuters.com/markets/europe/why-are-britains-pension-schemes-dumping-gilts-2022-09-28/ https://www.reuters.com/markets/europe/why-are-britains-pens...
- chewz 4y ago
  > the UK gilt crisis in December was related to pension funds holding long term gilts No, you got it wrong.. UK pension funds didn't have much gilts. UK pension funds had swaps on gilts and mostly assets equal to long term gilts (AAA rated). Like for example ownership of a parking lots in Germany, apartments in Norway - safe, steady cash flows. This is what chasing yields at zero interest rates does. Penions funds needed a window of few days to make a fire sale of these assets to meet their margin calls. It takes about two weeks from some junior analyst from BlackRock visiting said parking lot in Germany, checking books to BlackRock depositing money at UK Pension fund bank account. So Bank of England opened unlimited discount window for UK Pension funds for about two weeks. And then it closed. This is what happend.
  - 4y ago
deet 4y ago
Which part is silly though? The JPM report is indeed essentially saying that they didn't properly hedge interest rate risk. It just adds that SVB's situation was exacerbated by the fact that the health and size of the deposit base they had cultivated was also inversely correlated with interest rates (ie VC and startup activity declines with rising rates), which made their situation even more precarious than at other banks.

by chewz 4y ago

trailrunner46 4y ago

100% agree, taking huge unhedged duration risk and then loading up on negatively convex MBS again unhedged is so crazy.

runeks 4y ago

> Everyone who have ever managed bond portfolio knows that he must hedge interest rate risk. And every bank is doing that. How are other banks hedging interest rate risk? And how is the opposite end of this hedge hedging their position?

m3kw9 4y ago
Interest rate swaps maybe. Svb would be on the side that is getting a floating rate payment, while they pay a fixed one to the other side, so when the rates increase it would offset the loss in bond price. Thing is I’m not sure if they need to hedge if the bonds are for 1 year because they will get the money back anyways
JumpCrisscross 4y ago
> how is the opposite end of this hedge hedging their position? Plenty of financial functions create natural short interest rate exposure. Like SVB, they have no business speculating on rates, so they hedge it away. (The Fed is also involved in the repo market.)
oarabbus_ 4y ago
Any regular bond holding would include a mix of maturities - 1, 2, 5, 10 year bonds. This provides constantly maturing bonds leading to liquid cash with yield on the longest term instruments.

m3kw9 4y ago

what’s the point of needing to hedge if you let the bonds expire and get the payment. You wouldn’t lose anything right?

runeks 4y ago
SVB just went bankrupt pursuing that strategy... That being said, I don't think it's possible for all banks to hedge interest rate risk. The risk, to the system as a whole, doesn't go away just because it's transferred to someone else.
- m3kw9 4y ago
  So their bond prices went down and made them bankrupt, how does the math work in simple terms?
  - runeks 4y ago
    In simple terms, a bond is a piece of paper that pays a dollar amount per year to the holder for N number of years, after which the initial price paid for the bond is returned to the holder. For example, a 10-year bond that pays $2 per year costs $100 today. That is, a piece of paper that pays $2 to the holder every year for 10 years, after which the holder gets its $100 back. Now, some time passes and the market thinks the above bond is too expensive. Instead, the market will only pay $50 for the above bond, ie. $50 to get $2 per year. This means that the price of another bond: the bond that pays $4 per year will now cost $100. This is the case because holding two bonds that cost $50 each and pay $2 per year is exactly equivalent to holding a single bond that pays $4 per year and costs $100. If the market price of a 10-year bond that pays $4 per year costs $100 then we say that the current rate of interest for the 10-year bond is 4%. If this rate of interest falls to 2%, it simply means that the market is now willing to pay $200 per year for a bond that pays $4 per year — or, equivalently, $100 for a bond that pays $2 per year.
    - tome 4y ago
      > after which the initial price paid for the bond is returned to the holder Probably better to say "face value". The initial price paid for the bond may well not be its face value.

wcoenen 4y ago

> Everyone who have ever managed bond portfolio knows that he must hedge interest rate risk. Just a thought: the UK gilt crisis in December was related to pension funds holding long term gilts. And these pension funds all properly hedge the interest rate risk, they normally don't care how rates evolve. However, the market value of the gilts was changing too fast for the hedging to work. My understanding is that money couldn't be moved around fast enough to meet margin calls. Which then caused a bad feedback loop of forced liquidations of gilts, and the Bank of England had to step in to handle the crisis. So with this new story of duration risk at SVB, I'm wondering now whether other banks are in danger. They may have hedged their duration risk, but what if the hedging mechanism turns out to be broken?

inconceivable 4y ago
it's even worse than that. the pension funds were selling swaps (paying variable rates). that's why the BoE needed to step in to buy gilts - to drive the yield down and stop the bleeding from both the variable payout and capital losses incurred when liquidating gilts at a loss. zirp has caused some pretty astounding fuckups and i'm sure there are many more to come. https://www.reuters.com/markets/europe/why-are-britains-pension-schemes-dumping-gilts-2022-09-28/ https://www.reuters.com/markets/europe/why-are-britains-pens...
chewz 4y ago
> the UK gilt crisis in December was related to pension funds holding long term gilts No, you got it wrong.. UK pension funds didn't have much gilts. UK pension funds had swaps on gilts and mostly assets equal to long term gilts (AAA rated). Like for example ownership of a parking lots in Germany, apartments in Norway - safe, steady cash flows. This is what chasing yields at zero interest rates does. Penions funds needed a window of few days to make a fire sale of these assets to meet their margin calls. It takes about two weeks from some junior analyst from BlackRock visiting said parking lot in Germany, checking books to BlackRock depositing money at UK Pension fund bank account. So Bank of England opened unlimited discount window for UK Pension funds for about two weeks. And then it closed. This is what happend.
- 4y ago

deet 4y ago

Which part is silly though? The JPM report is indeed essentially saying that they didn't properly hedge interest rate risk. It just adds that SVB's situation was exacerbated by the fact that the health and size of the deposit base they had cultivated was also inversely correlated with interest rates (ie VC and startup activity declines with rising rates), which made their situation even more precarious than at other banks.